Ch 2 The Risk

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The Entrepreneur’s Path

Since the IPO boom of the late nineties through more challenging recent times, we have interacted with more than 2,000 high growth companies which span the spectrum of advanced technology businesses.

Many of the companies we met became our clients and are following our disciplined approach to turn their ideas into products and services that customers buy. Are they all going to succeed? Probably not. Starting a new company is a very risky business.

FACTOID

Since 2004, a yearly average of 575,000 small businesses (about 20 percent) ceased operations. Three in ten new firms don’t make it past 24 months, and about half of the ones that do, don’t survive more than five years, according to Business Dynamics Statistics compiled by the U.S. Census Bureau.

On the other hand, for every three new companies that don’t make it through twenty-four months, seven others survive. And while about half of those seven fail in the next five years, the other half of them don’t. They continue, creating jobs, revenue, and breakthrough innovations. That is the funnel of startup innovation. Out of ten great ideas, two to three make it.

Building a Product and Building a Business Are not the Same Thing

Entrepreneurs are passionate about their technologies. In the beginning, the company, the product or service, and the technology are so closely related that it’s hard to think about them independently.

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From the start, innovators and entrepreneurs have to focus most of their energy and resources on developing their product. There is a tendency to give lip service, postpone, or totally ignore any analysis of the market they are hoping to serve and whether that market is substantial enough to support the new company.

“If you build it they will come” may work for the Field of Dreams or Trump Tower, but never, no not even once, in all our years of working with entrepreneurs have we seen this strategy work for a start-up company, no matter how innovative or amazing the technology, product, or service was.

The cold hard truth of high growth entrepreneurship is that unless you deliver a product or service that thousands and thousands of people want to buy and can pay for, your company will likely be one of the seven in ten that don’t succeed.

“Before you move very far or very fast in the direction of taking your idea, product, or service from concept to market, take the time to invest a portion of your scarce resources--including your passion, creativity, energy, money, and time--to finding out everything you possibly can about the market and customers you want to serve.”

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What Problem Are You Solving and for WhoM?

As an entrepreneur on the path to success, you must be able to articulate the market problem you are trying to solve.

Prove to yourself and others that there is reasonable basis for believing that the people and companies in the market you plan to serve will pay your company for your solution to the problem they have.

It isn’t to say that your product or service can’t be the secret sauce in your company’s success. Many times it is, but always, always view products and technologies in the context of the marketplace and the needs of potential customers.

As you think about your big idea, paraphrasing the words of entrepreneur and author, Guy Kawasaki in his book The art of the start, “What’s the big problem, and what’s your big solution?” Is the market clamoring for a solution that your product and service solves? Is this market large enough to create a business?

Another way to look at this issue is as follows: You have a product that solves a problem in the market. How large is the market? Is the product/market combination large enough to merit forming a company? Remember, a product does not make a company.

Let’s assume that you’ve performed the analysis and legwork to show how your company’s products and services can solve big problems in a large market. What’s next? What steps do you take to make your business be one of the seven in ten that gets through the first 24 months and goes on to survive five years or more? How do you find the potholes ahead of time?

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The Entrepreneur’s Risk Assessment

To say that entrepreneurial businesses are risky is kind of like saying the sky is blue. From day one, every new company faces risks.

High growth start-ups that gain traction, attract equity capital and great employees, and win the confidence of early adopters do so because they have determined where the risks are at every stage along the Entrepreneurial Path and have developed tactical and strategic plans to maneuver through.

Your company will face five areas of risk: product, market, business, finance, and execution.

Product: A tangible object, technology, or service offered for sale.

Market: A commercial activity where goods and services are sold.

Business: A commercial enterprise that produces a product or service to be sold to a market.

Finance: The capital and cash flow required to achieve milestones that lead to success.

Execution: The experience, skills, and processes required to carry out a business plan.

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The Entrepreneur’s Path

It’s also a given that predictions are imperfect and that there will be plenty of surprises and mistakes along the way, but if you start out anticipating that these will occur and conduct scenario planning in case they do, you will greatly enhance your chances of success.

The point is, if you want to attract investors’ attention, anticipate and quantify risks and allow for the inevitability of unexpected events in your business plan and business pitch.

Many entrepreneurs are used to being subject matter experts–especially if they are in a technology field. Instead of trying to show everyone what you do know, be coachable. Ask questions and listen to find out what you don’t know. It may be a much longer conversation than you expect.

The Entrepreneur’s Risk Assessment Process

The Entrepreneur’s Risk Assessment is a thought process which guides you through developing a mental foundation for your company’s business plan and capital strategy.

The following is not intended to be a cookbook for risk assessment, but rather a thought starter to help you think like an investor in your business, which in a very real way you are.

Keep in mind the path that we outlined in Chapter 1 as you read this chapter and refer back to Chart 1.2.

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Proof-of-Concept Stage Risk

Risk Profile: At the Proof-of-Concept Stage, you have a new product or technology that seems to have market potential.

You have limited financial resources and, unless you have founded a company before, your expertise in taking a product or service from concept to market is probably limited.

The product risk is that the product or service may not be feasible, may lack unique qualities that cannot be adequately protected, or may be too difficult or expensive to produce in quantity.

The market risk is that the entrepreneur has limited understanding or knowledge of the market and overstates the size or growth potential.

The business risk is that a great product or technology doesn’t always translate into a great business.

The finance risk is that funding for Proof-of-Concept is hard to find.

The execution risk is that the innovator or entrepreneur may lack business skills.

You gather evidence to prove (or disprove) that your technology or product is viable and capable of solving a particular problem for a particular market. You have developed an initial business plan and invested weeks and months of your own time, some of your own money, and maybe even resources from family and friends.

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The Entrepreneur’s Path

It’s time to make the call. Is your business a go, or no go? If it’s a go, you are ready to consider Seed Stage risk.

Seed Stage Risk

Risk Profile: The final design of the product or service is complete and your initial business plan is in place.

The company’s management team is incomplete. With no product revenues, the company is burning through cash and other resources.

The product risk is that the company is focused on product innovation rather than business development.

Intellectual property rights remain a concern.

The market risk is that unrealistic market study results cause misallocation of scarce resources.

The business risk is the company lacks depth in business formation and commercialization.

The finance risk is that cash flow is a problem and Seed Stage funding is difficult to find and attract.

The execution risk is that the management team is incomplete and stretched thin. Investors are looking for experienced teams, but the company can’t hire that experience until it receives funding.

As the company moves from Seed to Startup Stage, development of the product prototype continues.

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Startup Stage Risk

Risk Profile: The company continues to develop the product prototype, working toward specified milestone completion dates. Significant expenses are incurred with no product-related revenues. Companies that progress to the Startup Stage, usually experience their riskiest pre-revenue point in the “Valley of Death.�

The product risk is that as the product or service advances from development into production, new skills are needed.

The market risk is that field tests with customers are not positive or that competitors respond more rapidly than expected.

The business risk is that as decisions for strategic partnerships, licensing agreements, and channel strategies are needed, the founding management team may lack professional experience.

The finance risk is that significant expenses occur without produce revenue being realized.

The execution risk is that the founders and management team lose focus or resist implementing appropriate business controls. The founder or members of the early team may exit the business.

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The Entrepreneur’s Path

As business development moves into sales, the company builds marketing and customer relationships that position it for the moving the product into the market place to gain acceptance from paying customers.

Early Stage Risk

Risk Profile: The company has limited product revenues as the product enters the market place.

The product risk is that product features reveal a limited market-driven functionality after scaling up product.

The market risk is that the reality of the market is rarely as planned. Lower market acceptance, aggressive competition, and limited repeat business can affect revenue.

The business risk is that the company can’t make the transition from a Seed to Startup environment to a true mode of business operation.

The finance risk is that the burn rate exceeds capital and management focuses on sales instead of profits.

The execution risk is that founding management and employees cannot keep up with the accelerating pace of change and have difficulty adapting to new business strategies.

As products become established in the marketplace, physical distribution is finalized and required production facilities are contracted or built. The company initiates quality control and processes.

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Growth Stage Risk

Risk Profile: The company is in full production with the main product and is expanding distribution. Customers are paying for product or service. Management is in transition to a formal organization structure.

The product risk is that product features must be refined to stay competitive. The demand for new features drains human and financial resources.

The market risk is that there are problems with distribution, customer satisfaction, or features. Competitors respond to product launch.

The business risk is that focus and business skills become more of an issue as operational demands increase.

The finance risk is that poor strategies of resource allocation limit the ability to increase expertise through training or hiring and impact ability to execute new contracts with customers.

The execution risk is that the startup buzz is gone. Hiring new people and increased focus on roles causes employees to become more focused on their functional responsibilities and less focused on the overall company mission. The entrepreneurial culture can change.

As the company becomes more well-established in the marketplace, management must continually innovate to stay competitive.

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The Entrepreneur’s Path

Later Stage to Maturity Risk

Risk Profile: The ability to innovate in all areas – product, market, business, finance, and execution is vital to the firm’s long-term sustainability and growth.

The product risk is that volume declines as products mature.

The market risk is that the entrepreneur has limited understanding or knowledge of the market and overstates the size or growth potential.

The business risk is that the pressures of monthly and quarterly financial goals limit the ability and resources to innovate.

The finance risk is that poor strategies of resource allocation limit the ability to increase expertise through training or hiring and impact ability to execute new contracts with customers.

The execution risk is that a structured corporate environment makes it difficult to innovate.

In real life, companies are not built in a straightforward fashion. Every entrepreneurial situation is unique. For your company, the risks we’ve summarized in this chapter may occur “out of order.” But rest assured they will occur.

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Guiding Principles of Assessing and Managing Risk

Even though one of the best things about entrepreneurship is that there are no hard and fast rules, these principles will increase your efficiency and improve your company’s odds of survival.

• Become a student of the Entrepreneurial Path.

• Anticipate addressing the product, market, and business activities and risks of each stage before moving to the next stage on the path.

• Be credible and avoid common misconceptions of the entrepreneurial process.

• Learn everything possible about the customer.

• Achieve market validation as soon as possible – this means sales.

• Develop a profitable business model.

• Success depends on profit; profit depends on growth.

• Growth depends on sales; sales depend on new innovations.

• Don’t count on partners to do your selling for you.

• Accept that raising a significant amount of capital initially is not necessary or even desirable.

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Conclusion

When you are founding a company, preparing mentally for unwelcome or unexpected events helps you anticipate situations so that when you find your company in the heat of the battle, you have a head start on a game plan to tackle and conquer the risks.

This mental toughness positions you and your business to be among the 50 percent of new companies that survive five years or more.

Key Points

Building a product and building a business are not the same thing.

Successful companies turn their product or service into problem solving solutions for big markets.

All new companies face risks. It’s up to you as founder to understand the risks at every stage on the path and then to develop tactical and strategic plans to maneuver your way through.

Expect surprises every day.